Investing/Buying Promissory Notes/Trust Deeds with My Solo 401k

Large companies like fortune 500 companies have long invested their 401ks and pensions in notes/deeds to receive high returns. You can do the same with your self-directed Solo 401k. This type of investment is straight forward and can be very profitable. Further, you, as trustee of the Solo 401k have control to set the terms of the note from the rate of interest to the maturity date of the loan.

What is a promissory note?

A promissory note a promise to pay, and is a legal document that obligates the borrower to repay the loan at a determined interest rate during a specified period of time. When a Solo 401k participates in a note, if the borrower fails to meet his or her promise, your Solo 401k will have the right to foreclose on the property securing the note, and, ultimately, take possession of the property if the borrower does not pay.

The Promissory Note Terms

The note terms typically include the sum of money to be repaid to the Solo 401k, the interest rate to be paid on the loaned amount, and the length of the note (i.e., when the note requires full payment). Therefore, each of these variables affects the value of the note. The value of the note is also dependent on the borrower (i.e., the likelihood that the borrower will not default on the loan).

Promissory Note Payment Amount

Before investing Solo 401k funds in a promissory note, you should determine the value of the property securing the note. For instance, if the note is secured by real estate, the loan-to-value ratio, or LTV should be determined. A note with a lower loan-to-value ratio—in other words, a note in which the amount of money borrowed is smaller in relation to the property's value --is a better deal than a loan with a higher ratio. An example would be property with a value of $100,000 and a loan of either $30,000 (30-percent LTV) or $70,000 (70-percent LTV). The 30-percent LTV is a much more secure investment. Since the borrower has greater equity in this case, the borrower has more to lose and, therefore, more incentive to pay. Further, should you have to foreclose, your Solo 401k will gain an additional $70,000 in equity, instead of the $30,000 your Solo 401k would receive with the $70,000 loan.

Interest on Promissory Note

When investing your Solo 401k in notes, you will need to decide on interest to charge. There are two types of interest: simple and compound. Simple interest is interest that is paid on the principal, or the loan amount. For example, if your Solo 401k loaned $400 to your brother for a year and charged him 1 percent interest, at the end of the year, he would pay you $4 in interest plus the principal of $400, for a total of $404.

Compound interest is interest paid on both the principal and the accumulated interest of prior periods. If you loaned your brother $400 for one year but charged him 1 percent interest each day--put differently, if the interest were compounded daily--he would owe you $404 at the end of the first day, $408.04 at the end of the second day, and so on.

Types of Promissory Notes

Secured--generally considered safest of the loan types because it's backed by collateral such as real estate or equipment. If the borrower stops making note payments and therefore defaults, the lender (Solo 401k) will take over the asset securing the loan; in this case real estate or equipment instead of receiving payments.

Unsecured--because the loan is not secured by collateral (e.g., real estate or equipment), and if the borrower stops making payments, your Solo 401k's only option in trying to enforce payments is to take legal action against the borrower.

Processing the Promissory Note/Trust Deed Investment with Solo 401k

1. After you have drawn up the note or if the borrower has composed it, review the note to make sure it conforms to your Solo 401k requirements and is in compliance with the regulations.

2. Confirm that the lender is your Solo 401k (it should read as follows, for example: Jane Do Solo 401k Trust)

3. Sign all documents as trustee of your Solo 401k

4. Make investment using funds from your Solo 401k checking account

5. When note payments commence, deposit all payments to your Solo 401k checking account (therefore, all payments need to be made payable to your Solo 401k)

Solo 401k Participant Loan Facts: Borrowing from My Solo 401k

      You, as trustee/participant can take a loan/borrow from Solo 401k for any reason.

      The Solo 401k loan term is 5 years for general loans.

      The Solo 401k loan term can be more than 5 years not to exceed 15 years if used to purchase principal residence for you as trustee/participant of the Solo 401k.

      Solo 401k loan payments are made either monthly or quarterly

      The interest rate for Solo 401k loan is either: A certificate deposit rate plus 2 percent or the prime rate plus 1 percent.

      Solo 401k Loan payments are fixed payments consisting of interest and principal

      Solo 401k loan rules do not allow for Interest only payments or principal payments only.

      The maximum Solo 401k loan amount is either 50% of account balance or maximum amount of $50K.

      Example 1: Solo 401k balance is $50K; 50% of $50K = $25K (the Solo 401k maximum loan amount)

      Example 2: Solo 401k balance is $150K; 50% of $150K = $75K; however, the maximum permitted Solo 401k loan amount is $50K

      The minimum Solo 401k loan amount is $1,000.

      The Solo 401k rules require the following proper Solo 401k loan documentation:

      Solo 401k Loan Documentation:

• Solo 401k Loan Agreement
• Solo 401k Loan Application
• Solo 401k Loan Payment Amortization Schedule

You can obtain more information regarding borrowing/taking a participant loan from My Solo 401k at: http://www.mysolo401k.net/Solo401kLoan.html

My Solo 401k Useful Links to IRS Websites

You can find a lot of useful information on the IRS website regarding retirement plans such as Solo 401k, but a lot of times it's tough to sift through it. As a result, the following links to IRS web sites may be useful.

Tax Information for Retirement Plans. This is the IRS's retirement plans home page and contains links to information about retirement plan topics. www.irs.gov/retirement/index.html

IRS Retirement Plans Newsletters. This site has links to current and past editions of "Employer Plans News" and "Retirement News for Employers." These periodic newsletters contain information about current development, upcoming events, and other topics relating to retirement plans. www.irs.gov/retirement/content/0,,id=122812,00.html

IRS Forms and Publications. Us the links located at www.irs.ustreas.gov/formspubs/index.html to view and download forms and publications.

Internal Revenue Bulletins (IRBs). These are published weekly and provide IRS announcements, rulings and information pertaining to retirement plans such as Solo 401k. www.irs.ustreas.gov/businesses/lists/0,,id=98230,00.html

IRS Drop Library. Announcements, notices, and revenue rulings are displayed in the IRS Drop Library priot to publishing in an IRB. www.irs.gov/pub/irs-drop/

IRS Information Letters. These types of letters contain general statements of the law. They are provided in response to questions from taxpayers and congressional offices. Even though information letters are advisory only and have no binding effect o the IRS, nonetheless they can be used in comprehending the IRSs’ position on the issues they apply to. www.irs.gov/foia/lists/0,,id=97728,00.html

IRS Written Determinations. This site provides access to private letter rulings, technical advice memoranda, and chief counsel advice. Private letter rulings are taxpayer-specific rulings or determinations that re furnished by the IRS National Office in response to requests from taxpayers. Technical advice memoranda are written memoranda furnished by the IRS National Office upon request of a district director or chief appeals officer. Chief Counsel advice are written advice or instructions prepared by the Office of Chief Counsel and issued to field or service center employees of the IRS or Office of Chief Counsel. These written determinations cannot be used or cited as precedent, but they are helpful in determining the IRS's position, often on very specific facts. www.irs.gov/foia/lists/0,,id=97705,00.html

Internal Revenue Manual (IRM). The IRM serves as the single official compilation of policies, delegated authorities, procedures, instructions, and guidelines relating to the IRS's organization, functions, administration, an operations, The IRM is a good source for obtaining the IRS's procedures and policies. www.irs.gov/irm/index.html

Coordinated Issue Papers. Provide guidance to field examiners regarding issues that the IRS views a s significant. Although these papers are not official pronouncements on the issues, they do set forth the current thinking at the IRS. These papers are particularly relevant for understanding IRS audit positions. www.irs.gov/businesses/article/0,,id=96445,00.html

IRS Newsroom. The latest news releases, fact, sheets, and other IRS-related news items are available here. www.irs.ustreas.gov/newsroom/index.html

IRS News Release and Fact Sheet Archive. This site contains news releases, fact sheets, and tax tips that have been issued since 1997. www.irs.ustreas.gov/newsroom/lists/0,,id=98040,00.html

Hot Topics. Look here for information about "hot" items such as new programs and recent guidance.

http://www.irs.ustreas.gov/newsroom/article/0,,id=97322,00.html

Solo 401K: Exemption from prohibited transaction (PT) for Office Space & Other Necessary Services

Contracts or arrangements between a Solo 401k plan and a party in interest for office space or legal, accounting, and other services or combination of services are exempt from ERISA’s prohibition against transactions between plans and parties in interest if:

1.       The office space or services are “necessary” for the establishment or operation of the plan;

2.       The contract or arrangement under which the office space or services are furnished is reasonable; and

3.       No more than “reasonable compensation” is paid for the office space or services.

• See Section 408(b)(2) of ERISA for more information on this exemption.

•  Regulations issued by the Department clarify the terms "necessary service" (29 CFR §2550.408b-2(b)),"reasonable contract or arrangement" (29 CFR §2550.408b-2(c)) and "reasonable compensation" (29 CFR §2550.408b-2(d) and 2550.408c-2) as used in section 408(b)(2).

 The rules pertaining to prohibited transactions applicable to qualified plans including Solo 401k plans are listed under Section 406 of ERISA.

Consolidating Retirement Plans Using a Solo 401k

The Solo 401k plan offers business owners the opportunity to consolidate all of their retirement savings under one umbrella. All of the following types of tax-qualified retirement savings can be rolled or transferred into a Solo 401k plan.

• Traditional IRAs
• SEP IRAs
• Rollover or Conduit IRAs
• SIMPLE IRAs
• SIMPLE 401(k) Plans
• 401(k) Plans
• Profit Sharing Plans
• Money Purchase Pension Plans
• Defined Benefit Plans
• Government 457(b) Plans
• 403(b) Plans

Solo 401k: Rollover, Direct Rollover, and Transfer; what's the difference?

An individual may move assets between various types of retirement plans through a rollover, a direct rollover, or a transfer. However, each method results in different reporting and tax consequences.

Although the rollover, direct rollover, and transfer achieve the same result (the movement of retirement funds to a Solo 401k) there are clear-cut procedures for each process. These rules must be carefully followed to ensure that the movement of funds remains a tax-free transaction. These methods are discussed below.

ROLLOVER. A rollover takes place when and individual takes a distribution (i.e., physically takes possession of the check or assets) from his or her IRA or from a qualified plan such as a 401k or Solo 401k and then deposits the proceeds to another IRA or another Solo 401k. For purposes of the 60-day rule, the date on which a distribution is actually received is the start date of the 60-day period. See [Treas. Reg. 1.402 (c)-2, Q&A-11].  If assets in a traditional IRA, SEP or SIMPLE IRA are paid directly to the Solo 401k owner (i.e, made payable in his or her name without also listing the “401k” on the check, or in the case of an in-kind transfer (an asset—mutual fund, stock, notes or real estate), the releasing custodian or trustee will report the distribution on form 1099-R using either code 1-early distribution if you are under age 59 1/2, or code 7-normal distribution if your are age 59 ½ or older.  IMPORTANT: In the case where a qualified plan such as a profit sharing plan or 401k is being distributed as rollover, federal income tax withholding is required. See [I.R.C. 3405(a), 3405(b), 3405(c)]

With respect to a 401k or PSP, What tax amount must be withheld from a rollover distribution?

The amount of tax withholding on all rollover distributions is 20% of the amount being distributed. See [Treas. Reg. 31.3405 (c)-1, Q&A-11]      

DIRECT ROLLOVER. A direct rollover occurs when assets are moved directly from an IRA, SEP or SIMPLE IRA to a Solo 401k. Note that a direct rollover, which is similar to a transfer in some ways, is still different from a transfer in that tax reporting applies.

How is a direct rollover distribution reported for income tax purposes?

The custodian or trustee processing the outgoing-direct rollover is required to report the transaction on form 1099-R using Code G- direct rollovers of a traditional IRA, SEP or SIMPLE IRA to a Solo 401k. In other words, it is treated as a distribution that is immediately rolled over. See [Treas. Reg 31.3405 (c)-1, Q&A-16]. Lastly, a direct rollover is not subject to the 60-day rule.

How is a direct rollover accomplished?

The releasing trustee or custodian can transfer benefits in a direct rollover by wire transfer or mailing of check or assets to the Solo 401k trustee, who is usually the participant. IMPORTANT: If this method is used, the check must be made payable to the named Solo 401k trustee as trustee of the Solo 401k plan. The check must also indicate for whose benefit it is. See [Treas. Reg. 1.401(a)(31)-1, Q&A-4]

 Note: The terms rollover and transfer are often used interchangeably—in many cases, incorrectly.

May a SIMPLE IRA be rolled or directly rolled over to a Solo 401k?

Yes. After the expiration of the two-year period, an individual may take a tax-free rollover of a distribution from a SIMPLE IRA to a qualified plan such as a Solo 401k plan. See [I.R.C 408(d)(3)(G)]

TRANSFER. A transfer is a way of moving money or property, tax free, from one 401k to a Solo 401k. When the trustee of Solo 401k is also the participant, he or she receives the money or property in a direct transfer. As a result, it is vital that the check is made payable to the receiving Solo 401k trustee, for example as follows: “John Do, Trustee of the ABC Solo 401k Trust”). If stock or property is being transferred in-kind (stocks, real estate, etc., rather than cash), it must be reregistered in the name of the new Solo 401k trust.

Are Transfers tax reportable on Form 1099-R?

Yes, transfers are reported to the IRS. The releasing or sending organization  generates a 1099-R-Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., reflecting a distribution using code G.  Income tax withholding does not apply when moving funds from another 401k to a Solo 401k because the transaction is not considered a distribution from the 401k.

Can I receive the Transfer proceeds and deposit them?

Yes, a key component of a direct transfer is that the check is made payable to the receiving or accepting Solo 401k Trust. Thus, as long as the check is properly issued, the Solo 401k trustee may hand carry the check to the bank for deposit into his Solo 401k checking account.

Form 5500-EZ, Annual Return of One-Participant (Owners and Their Spouses) Retirement Plan

Form 5500-EZ, Annual Return of One-Participant (Owners and Their Spouses) Retirement Plan, is now available for 2010. Form 5500-EZ is the paper-only IRS form for use by certain one-participant plans to report required retirement plan information to the IRS

Copies of the related schedules and instructions are available on the EP Forms & Publications page. of IRS website:http://www.irs.gov/retirement/article/0,,id=96763,00.html

A one-participant plan (Solo 401k), for purposes of the Form 5500-EZ, means a retirement plan not subject to the annual ERISA Title I reporting requirements that only covers the owner, or the owner of a wholly-owned trade or business (whether or not incorporated) and his or her spouse, or partners, or partners and their spouses, of a business partnership.

A plan is not a one-participant plan if the plan benefits anyone besides the owner (or owner and spouse) or partners (or partners and their spouses).

Certain retirement plans maintained outside the U.S. primarily for the benefit of nonresident aliens must file Form 5500-EZ rather than Form 5500.


Filing Tip - Use Correct Mailing Address for Form 5500-EZ
Form 5500-EZ must be mailed to the IRS Offices in Ogden, UT to be processed. Mail to

Department of the Treasury
Internal Revenue Service
Ogden, UT 84201-0020

• How to Request Copies of Filed Forms 5500-EZ
  Requests for copies of filed Forms 5500-EZ are handled by the IRS and must be in writing. You can request copies of filed Forms 5500-EZ on Form 4506. Indicate the plan number on line 7 of Form 4506 along with the tax period/plan year. Alternatively, submit a written request that includes the plan number and plan year. There is a charge for each tax period/plan year requested (the fee is indicated on Form 4506). Your request should be sent to:

Internal Revenue Service
1973 North Rulon White Blvd
Attn: EP Accounts M/S 6552
Ogden, UT 84404

CONTRIBUTIONS OF PROPERTY ARE TAX DEDUCTIBLE

One of the most significant tax advantages offered by My Solo 401k is the current deduction available.

The Deduction rules work the same way regardless of whether My Solo 401k contribution is in cash or property. When contributing property to My Solo 401k, the following rules apply:

· If property is contributed, the amount of the contribution is the fair market value of that
   property for purposes of determining whether the contribution exceeds the Solo 401k deduction limit.

· The contribution of encumbered property is also prohibited.